Five ways ESG impacts shareholder value
There’s lots of debate about whether ESG considerations - the environmental, social and governance activities of a company - are material to investors.
As an individual, I care a lot about how a company is addressing climate change and therefore considered right alongside the financial return on my investment dollars. You might not care about environmental issues at all and worry only about earning the maximum return, and so you might believe the information is immaterial to you. That’s entirely up to you. Individual investors who are managing their own money are free to act on or ignore ESG data as they see fit.
But what about the money that’s invested on others’ behalf?
There is $37 trillion in U.S. retirement funds that are primarily managed by large asset managers. The investment professionals who manage this money and the funds it's invested in have a “fiduciary duty” to ensure the money is invested for long-term shareholder returns.
How this money is managed is where the debate around ESG and materiality is becoming heated. In some states, legislators have passed laws declaring ESG considerations to be “nonpecuniary” (not economic or financial in nature) and, therefore, not material. These states have blocked their pension boards and state treasurer’s staff from making any decisions using ESG data.
Are these legislators correct? Do ESG metrics have zero impact long-term shareholder returns?
To answer these questions, we drank lots of coffee and dug into recent research to learn how ESG failures impact investment returns.
Poor management of ESG is a common theme in bankrupt companies. Research found that 15 out of the 17 S&P 500 bankruptcies in the study were in companies with poor ESG scores five years before the failure.
ESG-related controversies correlate lower company valuation. The same study found major ESG‑related controversies were accompanied by peak‑to‑trough market capitalization losses of half a trillion dollars for large US companies.
Past ESG issues predict future stock performance issues. A study by Columbia law shows that shareholders who ignore a company’s past ESG problems are often hit with negative stock returns when ESG issues predictably surface again.
Lack of ESG transparency leads to shareholders being blindsided by sharp decreases in market value. There is a long history of boards and investors being blindsided by lapses in their company’s stewardship. Think BP’s Deepwater Horizon explosion in the Gulf of Mexico; Volkswagen’s manipulation of emission tests; Facebook’s data privacy violations; Kobe Steel’s falsification of product safety data; Odebrecht’s, Siemens’ and Airbus’ bribery violations; Uber, Google and Weinstein Co.’s sexual harassment scandals; etc.
Link between ESG and profitability exists. That’s right. It’s not all about the risk of failure. Businesses which express commitment to ESG have seen revenue jump 9.7% over the past three years versus only 4.5% for those that didn’t, says accountancy firm Moore Global.
The numbers are clear. ESG is a vital predictor of long-term shareholder returns that should not be ignored.
When a state decides to literally outlaw the use of ESG data in investment decisions, asset managers are blinded to very real risks to their investment portfolios. That’s the exact opposite of fiduciary duty.
At Climate Finance Action, we are working alongside a coalition of responsible investors and stakeholders to fight for the majority of Americans who understand that responsible corporate citizenship is the best path toward the long-term financial success of a company, and therefore is also one of the most reliable predictors of returns for its investors.